Fed Induced Wall Street Bubble Keeps Going – For Now Zero interets rates will keep stocks artificially high for longer than we thought. Is this what we call good news?

WASHINGTON – Right before the most recent Federal Open Market Committee, (FOMC), meeting, Wall Street was on edge. Would the Federal Reserve now run by Janet Yellen (finally) signal the end of the longest period of ZIRP (Zero Interest Rate Policy) in modern US history? In other words, after 6 years of extraordinary “accommodative” measures (Fed speak for easy money), are we going back to normal?

Fed induced Wall Street bubble

This is not a technical question just for people working in finance. This is not about making a few timely adjustments to investment portfolios in the light of different monetary policies that may or may not be announced.

No, there is a lot more going on here. What is at stake is the unsustainability of the current Wall Street boom without the support of zero interest rates mandated by the Fed that caused an absurd hypervaluation of stocks.

Put it differently, if and when the Fed will decide that interest rates have to be increased, Wall Street will take a hit, simply because current valuations are due mostly to the fact that investors have no where else to go, since any other form of investment yields zero interest, thanks to Fed policy. What we do not know is how big a hit.

When good news is bad news

And so, here is the perversion. Any time we get supposedly “good news” about lower unemployment, the stock market takes a hit. This sounds really odd. You would think that investors would gain confidence by looking at numbers indicating a more robust economy that creates more jobs. But no, what they think is that the Fed, by looking at the same jobs growth numbers, would have the evidence it needs to conclude that unemployment is back under control, and therefore it may be time to end ZIRP and jack up short-term interest rates, this way causing a market collapse.

The party is not over yet

Well, going back to the recent FOMC meeting, after the ritual announcement of what was decided, the market rallied. And the simple reason is that Fed announced nothing. Fed Chair Janet Yellen said that there may be indeed a time to consider raising interest rates, but that time is not as near as we thought it might be. And this is largely because the economy is not growing as much as the Fed had anticipated in 2014.

Translation: “Contrary to what we feared, the party is still on, and the Fed just told us that it will go on for quite a while. Therefore, fear not. Keep throwing money into stocks. At some point this thing will end. But not now.”

The Fed created a monster

This may look like lunacy. But it is pretty much what is going on. The truth is that after 6 years of ZIRP, the Fed has created a monster. It has monetized trillions of dollars of US debt. It has quadrupled its portfolio, and ZIRP has induced investors to put their money into Wall Street, unless they really prefer zero interest alternatives (the functional equivalent of the old mattress).

Mad rush for the door

And yet, the very thought of putting an end to this unprecedented financial distortion creates market gyrations. Imagine what will happen when ZIRP will be truly over. It is wishful thinking to assume that there will be an orderly exit from the most overvalued stocks. Most likely there will be a mad rush for the door. It will be a huge mess.

But there is no way to avoid this. This ZIRP absurdity has to end. Unless we really want to believe that ZIRP is normal, that the Fed can keep printing money for ever, and all will be well, because our Keynesian mandarins running the show from the Eccles Building really know what they are doing.

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